China Has Reverted to a Fixed Peg on the Dollar

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Global Trade, Macroeconomics

There has been a lot of comment (much of it unwelcome in the US anyway) from China recently about replacing the US dollar as the reserve currency. Nearly everyone (outside of various tin-pot republics that would like to see the US brought down to their level) realizes it is just talk and that for the medium term there is no way the dollar could be replaced by another currency or even by an IMF sponsored currency underwritten by special drawing rights as suggested in this WSJ article. The fact is China is getting worried that their massive dollar holdings ” either as currency or as treasury bills ” could be decimated if the value of the dollar slides. They possibly fear that this is the US administration’s long term aim to devalue the currency and via inflation, reduce the burden of US debt. The fact China achieved these massive dollar surpluses by artificially suppressing the renminbi exchange rate is a fact I am surprised the administration does not make more of an issue about.

However, the point remains that from a peg in the early years of this decade the currency was allowed to appreciate some 20% against the dollar following an announcement in July 2005. The intention stated at the time was that the currency would be allowed to rise against a basket of currencies and fluctuate within certain bands. This wasn’t implemented immediately, according to this well researched article. It was 2006 before the renminbi appreciated significantly and even then it was still weighted heavily to the dollar. In 2007, the weighting system evolved and a significant allowance (probably up to half) was given to the Euro and other currencies. As a result, the renminbi appreciated against the dollar because the Euro appreciated against the dollar. But since the collapse of Lehman Brothers the government’s formulaic weighting has moved completely back to the dollar with an almost fixed peg while the Euro has been allowed to fluctuate significantly.

What does this show? That rather than move towards a freely convertible currency, a pre-requisite of any currency being part of a global reserve currency basket, the Chinese have reverted to pegging the currency exclusively to the dollar. The question is what will the government do next? Will they allow the renminbi to resume its slow appreciation against the dollar seen in 2007/8 or not? With China’s export industries struggling to survive it would seem highly unlikely, but one thing is certain. Until the currency is allowed to fluctuate freely, China will not have earned its place at the table to discuss a global reserve currency.

–Stuart Burns

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